17th April 2019 / Beth Oleyar: What is Negative Gearing?

The term has been thrown around in the spotlight quite heavily in the lead up to the Federal election on May 18th this year, but it also has many people asking, what are the proposed changes and how does it affect the housing market?

Despite being labelled a key issue for the election in 2019, it might surprise you to know that negative gearing isn't used by 90 per cent of Australian taxpayers.

Regardless, the proposed policy changes to negative gearing by the Labor government are set to have an impact on the housing market in a number of ways.

If elected to government this year, Labor's commitment to improving housing affordability is partially based upon reforming the practice of negative gearing, which essentially 'aims to prevent property investors from writing off the losses from their property investments against the tax they pay on wages,' according to the Sydney Morning Herald.

In contrast, the Coalition has announced its intention to leave negative gearing as is, if elected.

So, what is negative gearing?

If an investor borrows money to purchase an investment property, this is known as gearing. In the same circumstance, if the interest on the loan turns out to be higher than the net rental income and the investor is making a loss, this is known as negative gearing.

Now, if your scratching your head trying to figure out why anyone would want to invest in a loss-making property, this is where it gets interesting.

Current tax laws in Australia enable an investor to deduct any losses from this practice from other forms of income, such as wages. This means, the investor can reduce their taxable income in that financial year.

Considering investors purchase property in order to make money, not lose it, Domain says, 'the idea behind buying a loss-making investment is that any short-term losses will be outweighed by long-term capital gains'.

Essentially, given the fact that rental income for an investment property is bound to increase over time as the property increases in value, a negatively geared property can become a positively geared property, once the income exceeds the interest and expenses.

Now, you might be asking yourself, what is a positive geared property?

According to Domain, 'positive gearing is when the interest on the loan is lower than the net rental income. Investors are liable to pay tax on this income at their marginal tax rate'.

Given Labor's proposed changes to limit negative gearing will only apply to recently constructed housing, investors will only be able to deduct net rental losses from their wage income on new properties. Under the plan, all investments made prior to these changes coming into effect will still be able to have claims processed against wage income.

While future property investors and the 1.25 million Australians who currently negatively gear aren't likely to be celebrating these plans any time soon, the Sydney Morning Herald refers to several potential upsides to limiting negative gearing.

The independent Parliamentary Budget Office has estimated Labor's change in policy will raise approximately $32.1 billion over the next ten years. As a result, the government would either be able to reduce other taxes, provides more services or improve the budget bottom line.

However, the Coalition has expressed concerns that implementing such changes could lead to lower property prices and higher rents.

AMP Chief Economist, Shane Oliver commented on the potential downward pressure on property prices as a result of Labor's proposed changes, suggesting now might not be the time to be making changes to tax breaks for property investors.

'The risk is that is just adds to the perfect storm that's around property prices at the moment. It adds to the uncertainty and pushes prices down even further'.

Despite recent falls in price, property in Australia is still very expensive, according to the ABC, especially when compared against international and historical data.

'Back in the 1980s and early 1990s, Australians could buy an average home for two to three times their average annual household income after tax. Today, it's between five and six times.'

While spectators say that Labor's changes are about helping 'first home buyers compete with investors', AMP Chief Economist urges caution, 'we all want more affordable housing…but we don't want that increase in affordability to happen so quickly that it damages the economy.'

In contrast, Shadow Treasurer, Chris Bowen, says, 'The tax system should not support someone buying their fifth, sixth or seventh house more than someone buying their first'.

The upcoming Federal election calls into question a number of matters regarding the Australian housing market this year. At the end of the day, whether you consider a party's proposed changes as either good or bad, this ultimately comes down to a matter of perspective.

Sources:

• How Does Negative Gearing Work
• Housing Explainer: Labor and Coalition policy on Negative Gearing and Capital Gains Tax
• Negative Gearing will Affect us all, Mostly for the Better
• Changes will be Made to the Negative Gearing and Capital Gains Tax by January Next year if Labor wins the May Election
• Labor's Negative Gearing Changes will force Property Prices down and Rent up, Study Says
• What is Negative Gearing and What are Labor's Proposed Changes?